Thursday, December 19, 2013

The tale of 0% EMI schemes --->> RBI's embargo -- >> An Analysis !

In April, Anita Singh, a 50-year-old housewife, purchased a microwave worth Rs 10,100 from a large retailer in Mumbai. The retailer lured her into a six-month easy payment scheme at zero per cent interest rate on her bank's credit card and told that all she was required to pay was an additional processing fee of Rs 500. Even though she had her savings to pay for it, she went ahead with the deal.

A careful look into the scheme now shows that while the bank converted her payments into six EMIs, she had to pay the initial two EMIs in the first month. So, effectively, it was six EMIs in five months and Rs 500 extra on the purchase of a microwave worth Rs 10,100. A simple calculation shows that the processing fee she paid works out to be an effective interest rate of 11.9 per cent for her purchase and that too upfront.

"I feel cheated. I thought I was being offered the product at zero interest rate but the processing fee is amounting to this high rate of interest," said Anita, who is a hard bargainer and always looks to get some extra discount on any product she purchases.

Often, what we perceive as economical always has tremendous economics behind it. Otherwise why would the seller be interested in selling something that which is fairly cheap to you?

The 0% interest Equated Monthly Instalments (EMIs) was one of the few attractive schemes which had received strong acceptance, is a case in the point. Recently, Reserve Bank of India asked banks to stop 0% interest charging schemes that allowed consumers to buy goods on equated monthly instalments. Banks used to offer these special schemes to consumers to buy anything and everything from kitchen appliances such as induction cookers to even high end electronic gadgets such as smart phones, tablets and LED television sets.

In financial parlance, you should never borrow to consume and worse if you are splurging on some electronic gadgets just to catch up with peers. The basic tenets of financial planning suggest that you should not borrow to splurge. It can overburden and may limit any scope to borrow for something essential. However, things are changing and sometimes people prefer to buy things by borrowing if they increase their efficiency or save their time. For example, working women want to own a microwave oven and a sales executive want to own a smart phone. And banks sensed an opportunity in this.

They introduced dedicated schemes to sell these products to customers who can borrow.

The only glitch here is that they are wrongly called 0% EMI schemes, where the consumers get the impression that they are not paying any interest.

Banks were making consumers either pay down payments and service charges that would take care of the interest due on the money paid to product manufacturers or they were negotiating discounts deals with product manufactures, wherein the discounts were not passed on to the customers.

In both cases, RBI feels that customer interests are compromised. Hence the regulator asked the bank to stop these deals immediately.

What RBI says ...!!

The RBI has, argued that under the subvention scheme it is banks' responsibility to make consumers fully aware of the bargain that they would get from the manufacturer or retailer and also pass on those benefits fully and indiscriminately.

"Thus in principle, banks should not resort to any practice that would distort the interest rate structure of a product as this vitiates the transparency in pricing mechanism which is very important for the customer to take informed decision," said the RBI.

RBI has also instructed banks to put a curb on the practice where merchant establishments levy fee as a percentage of the transaction value as charges on customers while they make payments for purchase through debit cards. "Such fee are not justifiable," said RBI adding that this calls for termination of relationship of bank with such establishments.

What do people unhappy with this decision say ?

Card issuers are also looking to approach the RBI to let them continue with the subvention schemes as its benefits everyone and they will on their part make full disclosure to consumers that interest payment for their purchase is being taken case either by merchant or the manufacturer.

"While only 25 per cent of consumer durable secondary sale is through consumer finance, 75 - 80 per cent of automobile secondary sale is through consumer finance. Hence, impact is more on automobiles not durables. Also, consumer durable finance is primarily through NBFCs, not banks, while automobile finance is routed majorly through banks," said Deba Ghoshal, marketing head, unitary product business group, Voltas.

Naturally, consumer goods companies are crying foul. They were banking on such schemes to drive their festival sales and with the RBI notification, cautious customers are likely to be stay away, they feel.

According to a report in the Business Standard, about 20-30 percent of consumer goods sales happen via such zero percent EMI schemes. Such schemes are usually offered for premium products. Nilesh Gupta, CEO of Mumbai-based consumer durable goods retailer Vijay Sales, has been quoted as saying that the size of transactions will come down by 15-20 percent. Future group CEO has termed the move as anti-consumption.

What it means for economy ?

True. It is likely to bring down the sales overall.

But in the long run it augurs well as consumers take informed decision.

Such schemes result in sentiment-driven purchases.

They inflate demand.

This is not good in a low-growth, high-inflation scenario, which is prevalent in India now.

Moreover, it is important that people know that in an economy where inflation is high, cash too comes at a higher price.

This will help restrict demand and in turn control inflation at least to an extent.

After all, the interest rate in the economy is trending upwards.

Zero interest rate schemes—especially when it is just name sake—will only distort the real picture.

The RBI is setting this anomaly right.

It's a move simply to discourage customers from purchasing consumer goods as RBI wants to decrease CAD and make inflows of dollars and maintain the foreign reserve. as we all know that all the electronics and consumer goods are imported to our country and paid in dollars. In long run it should be beneficial for our economy.

Conclusion !!! (what i feel)

Nothing is free in this world or any other world. Its a welcome move by RBI to save vulnerable customers(who don't apply their mind). Let the govt take some hint from this and ban (or atleast put some restriction) such schemes on retail products. (Like cosmetics companies offering 1 cream free with another or 10% free like offers, offering conditioners along with shampoo). Same should be done to all other retail product manufacturers who hide behind the mask of generosity but in reality lure costumers to buy unnecessary products.